AQR: Computers Dont Replace Human Stock Pickers,

They Augment Them

valuewalk.com /2017/09/discretionary-managers/

By Mark Melin 9/30/2017

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While the headlines might indicate the algorithmic apocalypse is upon us, and that robots will be directing
investment allocation decisions, the reality at present is far different. Rules-based or systematic fund
managers as opposed to Discretionary Managers are only a small percentage of the active management mix , a
new report from AQR Capital Management asserts. In fact, the issue of systematic funds taking over human,
discretionary stock picking shouldnt be considered from an either / or standpoint. When considering correlation
and portfolio balance, the issue it co-integration, not exclusion, the report says.

In 2010, Felix Salmon and Jon Stokes penned a Wired article that blared the headline Algorithms Take Control
Of Wall Street.

That article may have been a little ahead of its time, as the term Managed Futures and CTA were generally
unknown terms in mainstream finance. (It wasnt until nearly half a decade later than CNBC finally, for the first
time, used the term Managed Futures on its air.)

While that was an early call, perhaps the most vocal shot across the bow came from an industry professional in
2015.

Eventually the time will come that no human investment manager will be able to beat the computer, Two Sigma
Investment founder David Siegel said at a 2015 investment conference, setting off a seeming competition
between computer-based, algorithmic methods and human-driven, discretionary approaches to investing. A
binary, either / or option was in play.

A variant of that theme has played out ever since, with JPMorgans Marko Kolanovic saying in June 2017 that
only 10% of stock trading is old-fashioned, human-based stock picking. This algorithmic takeover thought was
first voiced by Tabb Groups Valerie Bogard in February 2017.

"I would say it is 90 percent algorithmic, but there is not a great way to quantify that," she was reported saying.
"Even though (people) may send an order through a sales desk, it is possible it is going through an algo."

Today, algorithms are the 900-pound gorilla in markets, that same article noted.

While the issue is typically played in terms of one side vanquishing the other, that might not be the situation.
There is meaningful nuance behind a systematic, rules-based approach to investing that doesnt point to an
algorithmic takeover, but rather a smart integration between humans and intelligent technology.

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AQR is one of the largest systematic mutual fund operators in the world. Its third quarter Alternative Thinking
report is titled Systematic versus Discretionary but it is really about the combination of the two to deliver better
investing results, not an either / or choice:

While it is fair to contrast systematic and discretionary approaches, we stress that they are not
opposites. Indeed, both systematic and discretionary managers pursue the same objective and
both can be fundamentally-oriented. That is, they can use very similar inputs, but in different
ways, to try and achieve the singular goal of improving investment performance.

Neither systematic nor discretionary managers are inherently superior. Each has the ability to
deliver good investment outcomes and, as we show in the data, there is little evidence that one
approach is better than the other.

The report notes that computer-based investment decision making is actually a small portion of the active
management space. Systematic mutual fund managers currently run 14% of the assets, up from 9% in 1999,
while such computer-based hedge funds total has reached 26%.

The issue should not be about a takeover, but rather an integration. Computer-based systems often use the
same fundamental logic to make value investing decisions, and at times there is an integration that is at work.
The report points out that discretionary managers have very different correlations to systematic managers,
making them a perfect complement in a portfolio, not a binary choice.

There are also other myths the report points to, such as all systematic strategies operate off the same trading
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signals. Considering correlation statistics among systematic managers disproves this myth. While the technical
market environments of price persistence, volatility and mean divergence may be common, how value is
extracted is very different from manager to manager.

The wild-eyed and often popular notion that computers are creating their own strategies from scratch is another
myth, as human judgment is involved at most every development step, the report notes.

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